Why 2014 may be a replay of 2004

The two largest positions in the Peattie Capital’s Reasonable Price portfolio both made major strategic announcements in early July, positioning themselves for further growth in my opinion.

Macquarie Infrastructure Trust (MIC) bought the 50% of its International-Matex Tank Terminal subsidiary it didn’t already own and also announced its intention to raise the dividend again, this time to $0.95 per quarter.

MIC may still have room to grow in my opinion, and the company plans to payout of 80%-85% of proportionate free cash flow, which is expected to be $4.55 in 2014 and more than $5 in 2015.

KVH Industries (KVHI) announced it was buying Videotel, “a producer of high-quality training films and e-learning services for the commercial maritime industry.”

Videotel already services 11,000 vessels and is expected to create meaningful cross-selling opportunities for KVHI. In addition, 93% of Videotel’s revenue is subscription-based, and gross margins are more than 73%. Marine satellite-based communications is an evolving industry and I am very excited about KVHI’s position in it.

Small caps are down across the board through July, with small cap growth the poorest performing equity asset class at -4.6%.

I attribute this to the tapering of the Fed’s quantitative easing (QE) program, as smaller names tend to perform best when liquidity is most plentiful.

For quite a while the markets have responded favorably to all economic news. However, we may be entering, a new phase, wherein good news is bad news, as it may bring forth an earlier than expected end to QE.

My own guess is that Federal Reserve Chairwoman Janet Yellen will stay on her stated course, as changing it would lead to more confusion and possibly damage her credibility.

To be sure, there are myriad issues cited for the market’s recent performance. Among them: the upcoming change in monetary policy and Yellen’s highlighting a couple specific sectors, military activity in the Middle East and Ukraine, and election-year politics heating up in the U.S, along with a variety of domestic issues.

In addition, sentiment indicators are flashing yellow as too many investors are either optimistic or complacent, and I would much prefer to be buying stocks when sentiment is negative.

As to valuation, broadly speaking the markets are neither cheap nor expensive, as the average trailing price-earnings ratio for the S&P 500 is 17x when inflation is between 0-4%, which is about where we are now, according to a recent research report by Byron Wien.

I’ve said several times that I wouldn’t be surprised to see a 5-10% correction somewhere along the way, which would be normal and healthy. However I don’t see that as a game-changer, nor do I see a recession looming.

This year is shaping up in a manner somewhat similar to 2004, also a midterm election year, in which the markets were choppy and flat through September, and then returned nearly 10% in the fourth quarter.

On the plus side, the economy is growing, with the attendant pickup in employment, earnings are robust, liquidity is still plentiful and merger activity is rising. On top of that, absolute interest rates are extraordinarily low by historical standards, oil prices are falling and corporate balance sheets remain strong.

Equities still represent a viable alternative to bonds while lending and capital spending is accelerating.

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DISCLAIMER: The investments discussed are held in client accounts as of July 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.